Permanent Life Insurance and a Volatile Market

What You Need to Know

Stocks are doing well. That could change.
Annuities zig when stocks zag.
So do permanent life policies, and the tax rules are different.

Today, clients who are nearing retirement age face a climate of uncertainty.

With inflation at historic levels, climbing interest rates, and market whipsawing, it’s a tumultuous time to plan for the long term. The markets did well in the second quarter, but who knows what will happen in the third quarter? Or the fourth quarter?

To reassure their clients and provide ballast as part of thoughtfully constructed portfolios, advisors would be wise to consider permanent life insurance, a tax-advantaged vehicle for protection that fits a number of client needs.

While not an all-purpose solution, permanent life insurance can be a meaningful part of a financial plan to help convert yesterday’s market gains and today’s careful savings into tomorrow’s safe and reliable retirement.

While life insurance isn’t an asset class per se, there is a ripe opportunity for advisors to use it as a potent planning tool.

A Beacon of Hope

As the Fed has continued to raise rates, depressing the yields of otherwise safe investments, many retirement savers are understandably worried.

Last year, investors struggled to find a safe haven as bond markets experienced their “worst annual performance since the inception of Morningstar’s fixed-income indexes.”

Equities performed similarly, with analyst Meb Faber declaring that 2022 was “likely to be the worst year ever for a traditional 60/40 stocks and bonds portfolio.”

But even as the S&P fell nearly 20% last year, the cash value of virtually all permanent life insurance products remained fixed or had a positive return, preserving capital for investors.

Holders of these policies were better able to adhere to their plans, even as the value of their other investments fell.

The flexibility offered by these supplemental funds offered savers the ability to weather the storm.

One counterintuitive impact of higher interest rates is that, as traditionally safe investments face headwinds, the features and returns on life insurance policies become more competitive.

Rising rates lead carriers to increase benefits (such as no-lapse guarantees), as well as increase the crediting rates that cash value in life insurance policies grow, offering better risk-adjusted returns for many investors.

The Flexibility Edge

Like any financial planning tool, advisors must consider their clients’ individual situation and strike the right balance when recommending an insurance strategy.

Clients with straightforward protection needs may benefit most from the comparatively lower initial premiums that term insurance offers.

For clients with more complex needs, though, term insurance’s lack of cash value accumulation and the potential for higher premiums upon renewal can be limiting.

In these cases, permanent life insurance offers clients death benefit protection, cash value accumulation and flexibility for their retirement planning and emergency needs.

Clients can also fund a permanent policy upfront with a lump sum payment, building immediate cash value and potentially unlocking savings and estate planning benefits.

Not only can permanent life insurance be structured to protect savers from some downside risk, but the last few years have also shown that life paths are less linear than they were a decade ago.

There is no longer a one-size-fits-all (or most) model for planning for retirement.

Instead, as retirement timelines become more divergent, flexibility can be just as important as security.

Of course, permanent life insurance isn’t ideal for every client scenario.

Premiums can be higher than term insurance for a comparative face value, and the policies tend to be more complex.

Clients must also be aware that, for many policies, cashing out the policy early can incur surrender charges that diminish the liquid cash value of the policy — though policy loans could be used to offset this.

A Permanent Life Insurance Case Study

Consider a client who wants to retire at 55.

If she were to withdraw savings from a traditional qualified retirement account, she would incur early withdrawal penalties on top of taxes on income and gains.

Life insurance presents a solution.

As opposed to retirement accounts and annuities, where withdrawals are taken first from the returns (last-in, first-out), cash pulled from a life insurance policy is first taken from the principal (the premiums paid), which, if structured correctly, is not a taxable event.

Pre-retirement, life insurance liquidity can also be easier to access in the event of an emergency or unplanned major expense.

Conversely, hardship withdrawals from qualified plans are often capped and come with strenuous limitations, while 401(k) loans are not available to every saver and can take several weeks to get through the approval and disbursement process.

In times of need, the cash value of a life insurance policy can provide an accessible source of capital.

During retirement, cash value policies can provide access to funds without creating a taxable event.

Life insurance owners can also often borrow against their policy in just a few days to meet emergency obligations, without incurring taxes or penalties.

If the holder does not repay the policy loan, the amount will simply be deducted from the death benefit.

Where clients do not have a need for life insurance, traditional retirement investments are likely the best choice.

But for savers with a need for life insurance, such as a need for income protection, estate planning, business succession planning or charitable giving, permanent life insurance generally offers flexibility and the prospect of tax-advantaged, moderate growth.

For many, it can provide the keel that keeps a larger portfolio afloat and steady during a market upheaval.

Michael Konialian is the co-founder and CEO of Modern Life, a digital life insurance brokerage for advisors.

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